You bail me out, I'll bail you out

Published 6:00 am, Wednesday, December 30, 2009

Earlier this month, President Barack Obama met with the heads of some of the biggest banks to urge them to lend more.

The bankers aren't likely to heed the president's advice, and he knows it.

After all, his Treasury Department is helping ensure that the banks keep their money out of the private sector. The structure of the bank bailouts engineered by the Treasury and the Federal Reserve gives banks no incentive to lend.

More than a year after enacting the Troubled Asset Relief Program, the government still can't decide what it wants its bailouts to do: bolster banks' capital structure or encourage lending.

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For about three decades, Congress and banking regulators have steadily loosened banks' capital requirements, allowing them to lend more and keep less capital in reserve against losses.

Last year's TARP money began flowing into the banks about the same time that regulators started cracking down. In discussions I've had with local bankers recently, they say they've endured some of the harshest examinations of their careers. The president and Congress may want them to lend more, but regulators want them to minimize risk.

For the big banks, the problem is even more profound. Many of them still have gobs of toxic assets on their books, much of its masked by accounting tricks that give those assets higher values than the market would if they were sold.

In other words, despite all the TARP payback fanfare, many of the big banks are probably still undercapitalized.

As any banker will tell you, the last thing you want to do in that situation is make a bunch of loans — which all have some element of risk — when there's a safer alternative.

The Fed, you may recall, slashed the fed funds rate — what banks pay to borrow money — essentially to zero. So banks can take that virtually free money and use it to buy 10-year Treasury bonds, which are paying about 3 percent interest. In these uncertain economic times, that's not bad for a low-risk return.

Add some trading revenue from a rising stock market, ladle on some jacked-up fees from unsuspecting savers and credit card customers and — voila! — you have a recipe for solid profits with minimal risk just a year after seeking the government's help to stay in business.

As of Dec. 9, banks held $1.42 trillion worth of debt issued by the Treasury, Fannie Mae and Freddie Mac, according to the Fed's latest loan data. At the same time, they had $1.35 trillion worth of commercial and industrial loans. During the past year, the amount invested in Treasuries rose 15 percent while the loan amounts fell 17 percent.

In other words, banks are investing more in the government than the economy.

All of this may help stabilize the banks, which became TARP's goal after its goal was no longer to encourage lending. But the irony is that if the banks aren't lending, then stabilizing them isn't as important. We've essentially paid billions to make them less relevant to the recovery.

It isn't all bad. As long as banks aren't lending and unemployment remains high, we don't have to worry about inflation caused by all the money the government has dumped into the economy.

But it's also slowing the recovery because companies that can't borrow money aren't able to expand or hire. In addition, it helps finance the ballooning federal budget deficit and keeps Treasury rates low.

Based on recent surveys, the bigger banks don't plan to change their course anytime soon, so this could persist well into the new year.

If the president is serious about encouraging lending, then he should champion incentives for getting banks to make loans.

Perhaps he could direct the Treasury to use the leftover TARP money to do what TARP was originally designed to do.

The next time the president wants to tell the bankers to lend more, maybe he should go to New York. They could all take in a show, rather than having everyone come to Washington to give us one.